THE ROLE OF NATURAL RESOURCES IN ECONOMIC DEVELOPMENT

Economists
now recognize that, along with physical and human capital, environmental
resources should be viewed as important economic assets, which can be called natural
capital. Three recent debates have emerged over the role of natural capital
in economic development. First, as many ecological services are unique, does
the environment have an “essential” role in sustaining human welfare, and if
so, are special “compensation rules” required ensuring that future welfare is
not worsened by natural capital depletion today? Second, the environmental
Kuznets curve (EKC) hypothesis has fostered empirical estimations of an
“inverted U” shaped relationship between a variety of indicators of
environmental pollution or resource depletion and the level of per capita income.

Does the existence of such EKC relationships suggest that environmental
degradation will eventually decline with growth? Finally, recent economic
theories and empirical evidence have questioned whether lower income economies
that are endowed with abundant natural resources develop more rapidly than
economies that are relatively resource poor. Is it possible that resource
abundant economies are not reinvesting the rents generated from natural resource
exploitation into productive assets, or that resource booms actually divert
economic resources from more productive and innovative sectors?

I .
Introduction

Compared
to some other academic disciplines, economics is not known for being
particularly tolerant of revisions to its “mainstream” core concepts or
paradigms. Yet, today a major change is occurring in the economic view of the
world, and it is likely to have profound implications for many years to come. Surprisingly,
however, contemporary economists appear to be largely unaware that their
“worldview” is undergoing such an important change. Perhaps one reason is that,
unlike previous major innovations in economic thinking, there is no one person
responsible or associated with the new doctrine, such as a Karl Marx with
“Marxism”, a John Maynard Keynes with “Keynesian economics”, a John Nash with a
“Nash equilibrium”, or a Milton Friedman with “monetarism”. Perhaps another
reason is that the change in economic thinking has been fairly gradual and unheralded.
Just as it is hard to pinpoint a single individual, or even a group of
like-minded individuals, as being responsible for this changing worldview, it
is difficult to find a particular body of work, journal articles or books that
has instigated this change. Instead, in this instance economic thinking is
evolving more as the result of outside influences and pressures, such as the
need for economics to be “relevant” to contemporary policy issues and problems.
So what exactly is this gradual, largely unnoticed, yet possibly profound
change in the economic worldview? Simply put, the age-old concept of the
“economic system” has been irrevocably changed. No longer do we consider the
economic process of producing goods and services and generating human welfare to
be solely dependent on the accumulation of physical and human capital. That is,
an increasing number of economists now accept that there is a third

form
of “capital” or “economic asset” that is also crucial to the functioning of the
economic system of production, consumption and overall welfare. This distinct
category consists of the natural and environmental resource endowment available
to an economy, which is often referred to generally as natural capital. The
rest of this lecture is devoted to elaborating further on the “new thinking”
concerning the relationship between natural resources and economic development,
and in particular, on the key issues and debates that are emerging from this
thinking. As a useful starting point, I will characterize briefly how physical,
human and natural capital are now thought to contribute to the functioning of
an economic system. What becomes immediately clear is that the services
provided by natural capital are unique, and in the case of the ecological
services and life-support functions of the environment, are not well
understood. As a result, there has also been considerable debate over the role
of natural capital in “sustainable” economic development. That is, does the
environment have an “essential” role in sustaining human welfare, and if so,
are special “compensation rules” required to ensure that future generations are
not made worse off by natural capital depletion today? A further debate has
emerged over whether environmental degradation in an economy may initially
increase, but eventually declines, as per capita income increases.
Empirical verification of this environmental Kuznets curve hypothesis
has occasionally been cited as evidence that economies will be able to overcome
certain environmental problems through further economic growth and development.
Finally, recent economic theories and empirical evidence have questioned
whether poorer economies that are endowed with abundant natural resources
develop more rapidly than economies that are relatively resource poor. It is
often argued that resource-abundant economies are not reinvesting the rents
generated from natural resource exploitation into productive assets, or that
commodity price booms actually divert economic resources from more productive
and innovative sectors. In sum, our understanding of the role of natural
resources in economic development has advanced considerably in recent years,
although there is still much more to learn. In the rest of this lecture, I will
try to convince you that what we do know about this role is sufficient to
recognize that efficient and sustainable management of natural resources is a
critical policy objective for the economic process. We can no longer exclude
natural capital from any meaningful discussion of the factors determining
economic development. Our concept of the “economic system” has indeed changed
irrevocably.

NATURAL
CAPITAL AND THE ECONOMIC SYSTEM

Figure
1 depicts the basic relationship between physical, human and natural capital
and the economic system. Human-made, or physical, capital (KP), natural
capital (KN) and human capital (KH) all contributeto human
welfare through supporting the production of goods and services in the economic
process. For example, KP, consists of machinery, equipment, factory
buildings, tools and other investment goods that are used in production; KN is
used for material and energy inputs into production, acts as a “sink” for waste
emissions from the economic process, and provides a variety of “ecological
services” to sustain production, such as nutrient recycling, watershed protection
and catchment functions, and climate regulation; and KH includes the
human skills necessary for advanced production processes and for research and
development activities that lead to technical innovation. However, all three
forms of capital also contribute directly to human welfare independently of
their contributions through the economic process. For instance, included in
physical capital, KP, is fine architecture and other physical components
of cultural heritage; KN includes aesthetically pleasing natural
landscapes, and provides a variety of ecological services that are essential
for supporting life; and increases in KH also contribute moregenerally
to increases in the overall stock of human knowledge. One way of illustrating
how unique are the various “goods and services” produced by natural capital is
to examine the various economic values that arise through the functioning of a
natural ecosystem. For example, most natural ecosystems generate multiple
benefits, or values.

Table
I illustrates this with the example of an aquatic ecosystem. As shown in the
table, the concept of total economic value (TEV) is one framework that
economists have developed for categorizing Figure 1. Human, physical and
natural capital and the economic system

Source:
Adapted from Pearce and Barbier (2000).

Table
I Classification of total economic values for aquatic ecosystems

USE VALUES NON-USE VALUES

Direct
Use Values Indirect Use Values

Existence
Values

Bequest
Values

• fish
• nutrient retention/cycling • biodiversity

• aquaculture
• culture, heritage

• transport
• flood control

• wild
resources • storm protection

• potable
water • external ecosystem support

• recreation

• genetic
material • shoreline/river bank stabilisation

• scientific/educational

Source:
Adapted from Barbier (1994).

the
various multiple benefits arising from natural systems such as an aquatic
ecosystem.

Total
economic value distinguishes between use values and non-usevalues,
the latter referring to those current or future (potential) values associated
with an environmental resource which rely merely on its continued existence and
are unrelated to use. Typically, use values involve some human ‘interaction’
with the resource whereas non-use values do not.

Use
values are also grouped according to whether they are direct or indirect.
The former

refers
to both consumptive and non-consumptive uses that involve some
form of direct physical interaction with the resources and services of the
system: harvesting of fish and wild resources, transport and use for recreation
and tourism. It is also increasingly being recognized that the livelihoods of
populations in areas neighbouring aquatic ecosystems may be affected by certain
key regulatory ecological functions (e.g. storm /flood protection, water
purification, habitat functions, etc.). The values derived from these functions
are considered to be “indirect”, as they occur through the support and
protection of economic activities that have directly measurable values (e.g.
property and land values, drinking supplies, commercial fishing, etc.). Many
unique natural environments are considered to have substantial existence
values, in that many individuals do not make use of these environments but
nevertheless wish to see them preserved “in their own right”. Other important
non-use values are bequest and cultural

heritage
values. The Everglades in Florida or the Great Barrier Reef off the coast of
Australia are unique ecosystems that we may wish future generations to enjoy in
a fairly “intact” state and that are also considered important components of
national and cultural heritage.

NATURAL
CAPITAL AND SUSTAINABLE DEVELOPMENT

The
importance of the total capital stock concept to sustainability is illustrated
in Figure 2, which summarises broadly the economic view of sustainable
development. Most economic interpretations of sustainability take as their
starting point the consensus reached by the World Commission on Environment and
Development (the WCED, or Brundtland Commission). The WCED defined sustainable
development as “development that meets the needs of the present without
compromising the ability of future generations to meet their own needs” (WCED
1987). Economists are generally comfortable with this broad interpretation of
sustainability, as it is easily translatable into economic terms: an increase
in well-being today should not have as its consequences a reduction in
well-being tomorrow.

That
is, future generations should be entitled to at least the same level of
economic opportunities – and thus at least the same level of economic welfare –
as currently available to present generations. Consequently, economic
development today must ensure that future generations are left no worse off
than present generations. Or, as some economists have succinctly put it, per
capita welfare should not be declining over time

(Pezzey
1989). As noted in Figure 2, it is the total stock of capital employed
by the economic system, including natural capital, that determines the full
range of economic opportunities, and thus well-being, available to both present
and future generations. Society must decide how best to “use” its total capital
stock today to increase current economic activities and welfare, and how Although
as Bishop (1993) has pointed out, the objective of “sustainability” is
different from that of the standard economic objective of “efficiency.” That
is, there are potentially an infinite number of development paths for an
economy, only some of which are sustainable. Efficiency therefore does not
guarantee sustainability, as some efficient paths are not sustainable. At the
same time, there is no reason why an economy could not be both efficient and
sustainable much it needs to “save” or even “accumulate” for tomorrow, and ultimately,
for the well-being of future generations. However, it is not simply the
aggregate stock of capital in the economy that may matter butalso its
composition, in particular whether present generations are “using up” one form
of capital to meet the needs of today. For example, much of the recent interest
in sustainable development has risen out of concern that current economic
development may be leading to rapid accumulation of physical and human capital,
but at the expense of excessive depletion and degradation of natural capital.
The major concern has been that, by depleting the world’s stock of natural wealth
irreversibly, the development path chosen today will have detrimental
implications for the well-being of future generations. In other words, according
to this view, current economic development is essentially unsustainable.

While
it is generally accepted by most economists that economic development around the world is leading to the irreversible
depletion of natural capital, there is widespread disagreement as to whether
this necessarily implies that such development is inherently unsustainable. From
an economic standpoint, the critical issue of debate is not whether natural
capital is being

Figure
2. Sustainable economic development

Source:
Adapted from Pearce and Barbier (2000).

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AUSTRALIAN ECONOMIC PAPERS JUNE

Irreversibly
depleted, but whether we can compensate future generations for the current loss
of natural capital, and if that is possible, how much is required to compensate
future generations for this loss (Mäler 1995). However, economists concerned
with this problem appear to be divided into two camps over the special role of
natural capital in sustainable development. The main disagreement between these
two perspectives is whether natural capital has a unique or “essential” role in
sustaining human welfare, and thus whether special “compensation rules” are
required to ensure that future generations are not made worse off by natural
capital depletion today (see Figure 2). These two contrasting views are now
generally referred to as weak sustainability versus strong
sustainability

According
to the weak sustainability view, there is essentially no inherent
difference between natural and other forms of capital, and hence the same
“optimal depletion” rules ought to apply to both. As long as the natural
capital that is being depleted is replaced with even more valuable physical and
human capital, then the value of the aggregate stock – comprising human,
physical and the remaining natural capital – is increasing over time. Maintaining
and enhancing the total stock of all capital alone is sufficient to attain
sustainable development. In contrast, proponents of the strong
sustainability view argue that physical or human capital cannot substitute for
all the environmental resources comprising the natural capital stock, or all of
the ecological services performed by nature. Essentially, this view questions
whether, on the one hand, human and physical capital, and on the other, natural
capital, effectively comprise a single “homogeneous” total capital stock.
Uncertainty over many environmental values, in particular the value that future
generations may place on increasingly scarce natural resources and ecological
services, further limits our ability to determine whether we can adequately
compensate future generations for irreversible losses in essential natural
capital today. Thus the strong sustainability view suggests that environmental
resources and ecological services that are essential for human welfare and
cannot be easily substituted by human and physical capital should be protected
and not depleted. Maintaining or increasing the value of the total capital stock
over time in turn requires keeping the non-substitutable and essential
components of natural capital constant over time. The two sides in the debate
between weak and strong sustainability are not easy to reconcile. Recent
extensions to the economic theory of sustainable development have not so much resolved
this debate as sharpened its focus. It may take several generations before we
know for sure which view of the role of natural capital in sustainable
development is the correct one. Unfortunately, by then it may be too late to
correct many of the costly mistakes of the past.

IV.
Growth, Environment and the EKC A new area of enquiry has emerged in
environmental economics that also has important implications for sustainable
development. This recent literature is concerned with the analysis of environmental
Kuznets curves (EKC), i.e. the hypothesis that there exists an “inverted U”
shaped relationship between a variety of indicators of environmental pollution
or resource

For
further discussion of this distinction between weak and strong sustainability
see Howarth and Norgaard (1995); Pearce, Markandya and Barbier (1989); Pearce
and Barbier (2000); Toman, Pezzey and Krautkraemer (1995) and Turner (1993).

Note,
however, that rapid population growth may imply that the value of the per
capita

Aggregate
capital stock is declining even if the total value stays the same. Moreover,
even if the per capita value of the asset base were maintained, it may
not imply non-declining welfare of the majority of people. These considerations
also hold for the ‘strong sustainability’ arguments discussed below.

The
implication of this hypothesis is that, as per capita income increases,
environmental degradation rises initially but then eventually declines. Figure
3 shows a typical EKC estimated for sulfur dioxide (SO2). Although estimations
of such EKC relationships began in the early 1990s, interest in these studies
is likely to continue for some time. There are several reasons for this. First,
the EKC is a falsifiable hypothesis that can and will continue to be tested
through empirical investigation. Thus an increasing number of studies are
attempting to determine whether the EKC hypothesis holds for various indicators
of environmental degradation, both over time and across countries, regions,
states, districts and even cities.

Second,
the EKC hypothesis poses an important intellectual challenge. Explanations as
to why environmental degradation should first increase then decline with income
have focused on a number of underlying causes, including:

The
concept of an environmental Kuznets curve (EKC) relationship draws its
inspiration from the income distribution theory developed by Kuznets (1955),
who hypothesised that there is an ‘inverted U’ relationship between an
indicator of income inequality and the level of income. However, the exact
origins of the EKC hypothesis are somewhat ambiguous, and appear to be the
product of numerous studies conducted simultaneously in the early 1990s. Most
sources point to the analysis by Grossman and Kreuger (1995) of air quality
measures in a cross-section of countries for different years, which was part of
a wider investigation into whether the claims that the economic growth
accompanying the North American Free Trade Agreement might foster greater
environmental degradation. Similarly, the study by Shafik (1994) was originally
a background paper for the World Bank’s enquiry into growth and environment
relationships for the World Development 1992 (World Bank 1992). Finally,
Panayotou (1995) offers perhaps the earliest and most detailed explanation of a
possible “Kuznets type U-shape relationship between the rate

of
environmental degradation and the level of economic development” in analysis conducted
for the World Employment Programme of the International Labour Office in 1992.

Figure
3. An Environmental Kuznets Curve for sulfur dioxide

Source:
Adapted from Panayotou (1995).

The
above curve is the environmental Kuznets curve for sulfur dioxide (SO2)
estimated across rich and poor countries of the world by Panayotou (1995). The
“peak” or “turning point” level of per capita income where SO2 levels
start to fall is around $5,000.

•the
effects of structural economic change on the use of the environment for
resource inputs and to assimilate waste;

• the
effects of increasing income on the demand for environmental quality; and

• the
types of environmental degradation and ecological processes.

It
is not yet clear which of these factors, if any, explain why we might observe
an EKC relationship.

For
example, many of the original explanations of the EKC hypothesis focused on changes
in the composition of goods and services due to structural shifts in the
economy, the efficiency of resource use, the composition of inputs, and
technological innovation. However, increasingly it has been recognized that the
effect of such changes on environment-income linkages are not “exogenous”
processes – determined by factors outside the economy – but are influenced by
policy choices (Andreoni and Levinson 2001; López 1994; Panayotou 1995 and 1997;
Stern et al.

1996;
World Bank 1992). Similarly, previous conjecture that environmental quality is
simply a “luxury good”, and thus the demand for improved environmental quality increases
more than proportionately with income, is proving difficult to substantiate
(Lieb

2002;
McConnell 1997). Finally, it is possible that EKC studies are providing
misleading information on environment-income linkages (Stern et al. 1996).
As discussed earlier in this paper, there is much that we do not know about key
ecological processes and functions, as well as the valuable services that they
provide. Even if we observe EKCs for certain indicators of pollution and
resource depletion, it does not necessarily follow that the overall health and
functioning of ecosystems will also improve as income increases.

Third,
and perhaps most importantly, the EKC hypothesis has revived interest in the
longstanding debate over the environmental implications of economic growth
(Ansuategi et al. 1998). One important interpretation of such estimated
curves is that economies will eventually “grow out of ” many environmental
problems (Beckerman 1992). Taken to its extreme, this argument suggests that we
do not have to regard the environment as anything special. As people get richer
they will increase their demand for the environment and improve it, initially with
public health legislation, then clean air, then conservation generally.

However,
other commentators have been more cautious, noting that conclusive evidence of an
EKC relationship applies only to a few pollutants, thus making it difficult to
use this evidence to speculate more generally about growth-environment linkages
(Arrow

et
al. 1995). Still others have pointed out that, even for those
pollutants displaying EKC characteristics, aggregate global emissions are
projected to rise over time, demonstrating that the existence of an EKC does
not necessarily imply that, at the global level, any associated environmental
damage is likely to disappear with economic growth (Selden and Song 1994; Stern
et al. 1996). Policy makers are following this renewed debate with
interest. From their perspective, the critical policy issue is whether economic
growth should continue to be the main priority, with protection of the
environment as a secondary consideration to be addressed mainly in the future,
or whether explicit policies to control environmental degradation at the local,
national and global level are required urgently today.

To
date, the empirical evidence suggests that EKC relationships are more likely to
hold for certain types of environmental damage, e.g. pollutants with more
short-term and local impacts, versus those with more global, indirect and
long-term impacts such as carbon dioxide and other greenhouse gases (Arrow et
al. 1995; Barbier 1997; Cole et al. 1997; Selden and Song 1994).

In
terms of types of “localised” environmental damage, the EKC hypothesis seems
mainly to be valid for air pollution, in particular sulfur dioxide (SO2) and to
a lesser extent solid particulate matter (SPM). The evidence for other
localised forms of environmental damage, such as water pollution,
deforestation, urban waste and toxic metals, is more mixed (Barbier 1997; Cole et
al. 1997). Moreover, environment-income relationships appear to vary across
individual countries.

For
example, a study for Malaysia found SPM to be increasing with income (Vincent
1997), whereas a study for the United States indicated that SPM and other major
air pollutants decline with increasing levels of income (Carson et al. 1997).

However,
even when an EKC relationship is estimated, often the turning point on the
curve, where environmental degradation starts to decline with per capita income,
proves to be very high relative to the current per capita GDP levels of
most countries of the world (Barbier 1997). For example, the turning point for
sulfur dioxide in Figure 3 is just under $5,000 per capita. In another
recent analysis, none of the estimated EKC turning points for various
environmental indicators are below the minimum income level of the sample of
countries analysed, and the turning points for nitrates, carbon dioxide, energy
consumption and traffic volumes are well above the maximum income of the
countries in the data set (Cole et al. 1997). In the case of those EKC
estimates for tropical deforestation that are robust, the per capita income
levels of most developing countries are also well to the left of the estimated
turning point peaks (Cropper and Griffiths 1994; Barbier and Burgess 2001; Koop
and Tole 1989).

Overall,
such results suggest that most countries have not yet reached levels of per
capita income for which environmental improvement is likely to occur. The
implications are a worsening global problem of environmental degradation as the
world economy and populations expand, even for those environmental indicators
that display EKCs (Selden and Song 1994; Stern et al. 1996). This can be
seen clearly in Figure 4. This figure shows the future trend in global sulfur dioxide
emissions based on the estimated EKC for SO2 depicted in Figure 3 and employing
aggregation of individual country projections of population and economic growth
over 1990 to 2025. The resulting projections show a rise in global sulfur
dioxide emissions throughout this period. For example, total global emissions
of SO2 rise from 383 million metric tons in 1990 to1,181 million metric tons in
2025, or from 73 to 142 kg per capita (Stern et al. 1996).5 Where
the EKC relationship does appear to hold, especially for certain air pollutants
withlocalised or short-term effects, there is evidence that the eventual
reduction in emissions associated with higher per capita income levels
may be attributable to the “abatement effect” that arises as countries become
richer (Andreoni and Levinson 2001; López 1994; Panayotou 1997). Also, both the
willingness and the ability of political jurisdictions to engage in and enforceimproved environmental regulations, to
increase public spending on environmental
research and development, or even to engage in multilateral agreements to
reduce emissions may also increase with per capita income levels (Carson
et al. 1997; de Bruyn 1997; Komen et al. 1997).6 However, it is a
great leap of faith to conclude from these results that economic growth on its
own will foster environmental improvement automatically. As Panayotou (1997)
has concluded, “when all effects are considered, the relationship between
growth and the environment turns out to be much more complex with wide scope
for active policy intervention to bring about more desirable (and in the
presence of market failures) more efficient economic and environmental outcomes.”

This
conclusion may be particularly relevant for low income and rapidly industrializing
developing countries, whose current per capita income levels are well
below the turning oints of most estimated EKCs. In the absence of national and
multilateral policy interventions, 5 Selden and Song (1994) conduct similar
projections for the four air pollutants for which they estimate an EKC
relationship, SO2, SPM, nitrogen dioxides (NOx) and carbon monoxide (CO). Their
results show world emissions increasing for all four pollutants through 2025,
and for SPM and NOx, emissions rise through 2050.

6 On
the other hand, corruption and bureaucratic inefficiency may also explain why
EKCs “break down” for certain countries. See López and Mitra (2000).

Environmental
degradation will continue in these countries as per capita income
increases, at least over the medium term. In this regard, the observation of
Vincent (1997) from his analysis of Malaysia is very apt: “The lack of evidence
of EKCs in Malaysia does not prove that EKCs do not exist anywhere. It does
indicate, however, that policy makers in developing countries should not assume
that economic growth will automatically solve air and water pollution problems.”
In sum, the implications of the EKC literature for sustainable development are
fairly straightforward. Regardless of whether one is an adherent of the weak
sustainability or strong sustainability view, estimated EKC relationships on
their own do not help us determine what actual policies are required in the
economy to manage its total capital stock, including its stock of natural capital.
Although recent EKC studies appear to have revived the wider “growth versus the
environment” debate, these studies offer very little support for the view that economic
growth alone is the solution to all environmental problems. Rather, it is clear
from the EKC literature that specific policies to protect the environment are
necessary to reduce environmental damages that are imposing real welfare
losses. As Arrow et al. (1995) have succinctly put it: “Economic growth
is not a panacea for environmental quality; indeed it is not even the main
issue.” V. Natural Resource Abundance and Economic Growth So far, we have
examined how management of environmental and natural resources, i.e. the natural
capital stock, of a country is important for achieving sustainable economic
development. We have also reviewed the recent findings of the EKC literature to
make the case that the causal relationship is from improved environmental
management to enhanced economic development and welfare, and not the other way
around.

Figure
4. Projected trends for global SO2 emissions

Source:
Stern et al. (1996).

It
is therefore tempting to conclude that, if natural capital is so important to sustainable
development, then more of a good thing must be even better. That is, economies
that have a greater endowment of natural resources must surely have a much
better chance of attaining higher economic growth rates and prosperity than
relatively resource-poor economies. This must be particularly true with respect
to low and middle-income countries, whose economies are generally more
dependent on exploiting their natural capital stock in the transition to
developing industrial and service sectors and the “take off ” into higher and
more balanced rates of long-run growth.

However,
if per capita income is to be sustained or increased in these economies,
especially with population increases, then any depreciation of natural
resources must be offset by investment in other productive assets. This implies
managing natural resources so as to maximize resource rents and channeling
those rents into productive investments elsewhere in the economy. Although it
would seem that the windfall profits generated by resource price booms would be
beneficial to this process, this may not be the case for resource-abundant
developing countries.

In
fact, recent evidence suggests that resource-abundant countries, especially
developing economies, may not be benefiting economically from this apparent
comparative advantage. Many low-income and lower middle-income economies that
can be classified as highly resource dependent today also currently display low
or stagnant growth rates (Barbier 1999). Crosscountry analysis has confirmed
that resource-abundant countries – i.e. countries with a high ratio of natural
resource exports to GDP – have tended to grow less rapidly than countries that are
relatively resource poor (Sachs and Warner 1997). Economies with a high ratio
of natural resource exports to GDP in 1971 also tended to have low growth rates
during the subsequent period 1971–89 (Sachs and Warner 1995).

Such
evidence might be considered surprising, given the commonly held view that
abundant natural resources ought to be the basis for economic expansion for
those countries fortunate to have such a rich endowment. For example, the
origins of rapid industrial and economic expansion in the US over 1879–1940
were strongly linked to the exploitation of abundant non-reproducible natural resources,
particularly energy and mineral resources (Romer 1996; Wright 1990). In particular,
during 1880–1920, the intensity of US manufacturing exports in terms of
nonreproducible resources grew both absolutely and relative to the
resource-intensity of imports.

However,
there is also evidence that there were other factors that made this historical
situation in the US unique. For example, Wright (1990) maintains that, over
this era:

• the
United States was not only the world’s largest mineral producing nation but
also one of the world’s largest countries and markets;

• high
international transport costs and tariff barriers for manufactured goods
compared to highly efficient and low cost domestic transportation meant that
the United States was a vast free trade area for internal commerce and
industrial expansion that benefited from

“economic
distance” from the rest of the world; and

• because
of the quantities of resources that were available combined with the large
internal markets for goods, increasing investment in basic technologies for
extracting and processing natural resources was highly profitable.

As
Wright (1990, pp. 665 and 661) suggests: “the abundance of mineral resources,
in other words, was itself an outgrowth of America’s technological progress,”
and in turn, “American producer and consumer goods were often specifically
designed for a resource-abundant environment”.

However,
it is doubtful that the unique circumstances over 1879–1940 that allowed the

United
States to achieve “congruence” between intensive resource use and basic
processing and manufacturing technologies, and thus attain rapid economic
expansion, are applicable to resource-abundant developing economies today. For
one, after 1940, this unique “congruence” had clearly ended for the United
States, largely due to changes in the international economy, even though the US
still had abundant resources. As Wright (1990, p. 665) points out: “the country
has not become ‘resource poor’ relative to others, but the unification of world
commodity markets (through transportation cost reductions and elimination of
trade barriers) has largely cut the link between domestic resources and
domestic industries. . . . To a degree, natural resources have become
commodities rather than part of the ‘factor endowment’ of individual countries.”
As some researchers have pointed out, the changed international conditions
during the post-war era may have also affected the role of primary-product
export promotion as the “engine of growth” for developing economies. During
this era, the main source of economic growth in developing countries has not
been primary-product based exports but labour-intensive

manufactured
exports (Findlay 1996; Findlay and Wellisz 1993).7 Not only are the conditions
for “congruence” between resource abundance, technological progress and
industrial expansion lacking in most developing economies today, but it is also
possible that increased economic dependence on resource exploitation may be
detrimental to innovation and growth. For example, recent explanations of the
limitations of resource-based development have focused on the poor potential
for such development in inducing the economy wide innovation necessary to
sustain growth in a small open economy. Matsuyama (1992) has shown that trade
liberalisation in a land-intensive economy could actually slow economic growth by
inducing the economy to shift resources away from manufacturing (which produces
learning induced growth) towards agriculture (which does not). Sachs and Warner
(1995) also argue that the relative structural importance of tradable
manufacturing versus natural resource sectors in an economy is critical to its
growth performance, i.e. when a mineral or oil-based economy experiences a
resource price boom, the manufacturing sector tends to shrink and the
non-traded goods sector tends to expand. This phenomenon is often referred to in
the literature as the “Dutch disease” effect. Sachs and Warner (1999) have
recently examined evidence over the period 1960–94 for eleven major Latin American
economies to test the hypothesis that any natural resource booms occurring in
these countries may have had a positive impact on their growth performance. First,
the authors note that the main structural feature of these economies is that
they have 7 From their case study analysis of five open developing economies,
Findlay and Wellisz (1993) concludethat over the post-war era it was economies
with relatively no resources, such as Hong Kong, Singapore and Malta, that were
among the earliest and most successful exporters of labour-intensive
manufactures. In contrast, resource-rich Jamaica and the Philippines have done
relatively poorly, whereas Indonesia and Malaysia have done comparatively
better by balancing primary exports with rapid expansion of labourintensive manufactures.
Originally, the “Dutch disease” phenomenon was associated with the macroeconomic
implications of an economy’s over-dependence on a single, traded natural
resource sector (e.g. oil), which emphasised the enclave character of the sector
as the predominant source of foreign exchange availability (e.g. see Neary and
van Wijnbergen 1986). As the consequence of a resource price boom (e.g. oil
price shock), expansion of the resource-based sector would be accompanied by a
change in the real exchange rate, and the rest of the economy would decline
relatively. The more recent treatments of the “Dutch disease” phenomenon, such
as by Matsuyama (1992) and Sachs and Warner (1995) discussed here, focus less
on the economic implications of a resource boom via real exchange rate
movements but via internal economic distortions caused by the shift of
resources from a more innovative sector (e.g. manufacturing) to a less
innovative sector (e.g. agriculture, minerals). This latter representation of
the “Dutch disease” is more appropriate for characterising a small open
economy, in which real exchange rate determination is not considered. The
countries are Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico,
Paraguay, Peru, Uruguay and Venezuela remained by and large exporters of
primary commodities or manufactured products based on these commodities.
Second, they suggest that a significant resource boom occurred in only four of
the eleven countries (Bolivia, Ecuador, Mexico and Venezuela), and mixed
evidence of a boom in another three (Chile, Colombia and Peru). However, Sachs
and Warner conclude that in only one of these seven countries (Ecuador) did a
resource boom have a positive and lasting effect on GDP per capita. In
two countries (Chile and Colombia) there appears to be no effect

of a
resource boom on economic development, and in the remaining four cases
(Bolivia, Mexico, Peru and Venezuela), the resource boom actually produced a
negative impact on GDP per capita. On balance, resource booms appear to
frustrate economic growth in Latin America, most likely through a Dutch disease
effect.

If
natural resource booms are not important catalysts for economic development in
poorer countries, then perhaps the process of resource exploitation occurring in
these economies is not as economically beneficial as it could be. That is, the
structural economic dependence of a small open low or lower middle income
economy on exploiting its natural resource endowment may not be leading to
sustained and high rates of economic growth. This may be occurring because
natural resource assets, including land, are not being managed so as to
maximise rents and/or whatever rents are being generated in the economy are not
being channeled into productive investments elsewhere in the economy.

Brander
and Taylor (1997 and 1998) provide some theoretical support for this
perspective. They note that over-exploitation of many renewable natural
resources – particularly the conversion of forests to agricultural land –
occurs in developing countries if property rights over a resource stock are
hard to define, difficult to enforce or costly to administer. They demonstrate that
opening up trade for a resource-abundant economy with an open access renewable
resource may actually reduce welfare in that economy. As the resource-abundant
country has a comparative advantage in producing the resource good, the
increased demand for this good resulting from trade openness leads to greater
resource exploitation, which under conditions of open access leads to declining
welfare in the long run. Brander and Taylor conclude that, as the problem lies
with the “open access” nature of exploitation in the resource-abundant economy,
then the first-best policy would be for the developing country to switch to more
efficient resource management policy through simply establishing property
rights.10 However, as they acknowledge, there are many policy and institutional
distortions that currently work against such solutions in developing countries.
Consequently, Brander and Taylor (1997, p. 550) argue in favour of “second best
approaches”, such as the imposition of “a modified ‘Hartwick’s rule’ (see
Hartwick 1977) under which an exporting country that experienced temporary
gains from selling a resource good on world markets might re-invest those
proceeds in an alternative asset.” Current policies in resource-abundant
developing economies appear not to be ensuring that any resource rents earned
are re-invested efficiently into other productive assets in the economy (Pearce
and Barbier 2000). Such an outcome may be reinforced by corruption,
bureaucratic inefficiency and misguided policies that benefit special interests
that gain from short-term resource exploitation (Ascher 1999; Barbier and
Damania 2000; Deacon 1994). If this is the case, then irrespective of what may
happen to a country’s terms of trade or commodity prices, any initial “economic
boom” associated with land conversion or increased resource exploitation. In a
recent analysis of land expansion in Mexico, Barbier (2002) demonstrates that
institutional constraints, such as the ejido common-property land
management regime, may have slowed down the pace of land conversion and
deforestation in pre-NAFTA Mexico. However, increased trade liberalisation
under

NAFTA
combined with the widespread relaxing of the land management rules of the ejido
regime could accelerate land clearing in Mexico is invariably short-lived
as the extra rents generated are eventually dissipated. Once the land expansion
and increased exploitation of new resource “reserves” comes to an end, or
poorer quality land and resources are brought into production, then some
economic retrenchment is inevitable. What we should therefore observe is that
economic development in a resource dependent small open economy displays an
inherently “boom and bust” pattern. Again, Brander and Taylor (1997) show that
a small, open and resource-abundant economy that produces both a resource and a
manufacturing good in the long run will have such a pattern of development. That
is, the economy will experience early gains from trade, followed by a period of
declining utility. With the specific case of Latin America in mind, in which
raw materials are often inputs into semi-processed or processed exports, López
(1989) also develops a two-good model of a resource-rich open economy in which
the open access renewable resource serves as an input into an “enclave” export
processing sector. López demonstrates that improvements in the terms of trade
increases the rate of open access resource extraction and causes real income to
rise in the short-run, but inevitably permanent income falls in the long run. As
mentioned above, the classic case of open access resource exploitation in many
developing countries is conversion of forest to agriculture (Barbier and
Burgess 2001). If agricultural land expansion in these small open economies is
associated with a “boom and bust” pattern of economic development, then there
are two possible consequences. First, economies that have increased their agricultural
land base significantly over the long run are likely to have lower levels of
GDP per capita then economies that have tended to reduce their
dependence on agricultural land expansion. For the latter countries, a
shrinking agricultural land base may be evidence that tradable manufacturing
and other dynamic sectors have become structurally more important in the
economy relative to natural resource sectors and that agriculture itself has
become a more capital-intensive, productive and innovative sector.11 Second,
for those countries that aredependent on agricultural land expansion, further
increases in agricultural area will tend to produce only modest increases in
GDP per capita. Beyond a certain point, additional increases in land
expansion will be associated with lower GDP per capita, because of the
“boom and bust” pattern of resource-dependent development described above. A
fairly straightforward way of empirically verifying the above phenomenon is to
estimate a relationship between GDP per capita and some measure of long-run
agricultural expansion. For example, if the latter indicator was some index, ∀it,
then the above hypotheses suggest that there may be a cubic relationship
between per capita income, Yit, and this indicator of long run
agricultural land change

In
the above equation b0 > 0, b1 < 0, b2 > 0, b3
< 0 and | b1 | > b2 would imply that countries with increased
long run agricultural land area would have lower levels of per capita income
thancountries with decreased agricultural land area, and per capita income
would tend to fluctuate with long run agricultural land expansion. The above
relationship was estimated through employing a panel analysis of tropical
developing countries over 1961–94. Per capita income, Yit, is
represented by gross domestic product (GDP) per capita in constant
purchasing power parity (1987 $). The indicator ∀it is an agricultural land
long run change index, created by dividing the current (i.e. in year t)
agricultural land area of a country by its land area in 1961.12. In the small
open economy model of Brander and Taylor (1997), if the country specialises in
the manufacturing

good
in the long run, it gains unambiguously from trade.

The
data used in this analysis is from the World Bank’s World Development
Indicators.

The
results of the analysis for all tropical countries and for low and lower middle
income countries (i.e. those economies with real per capita GDP less
than $3,500 over 1961–94) are shown in Table II. For both regressions, the
estimated coefficients are highly significant and also have the expected signs
and relative magnitudes. Thus the estimations provide some empirical evidence
that agricultural land expansion in developing countries conforms to a “boom
and bust” pattern of economic development. This is seen more clearly when the
regressions are used to project respective relationships between long run
agricultural land expansion and GDP per capita, which are displayed in
Figure 5.

As
indicated in the figure, an increase in agricultural land expansion in the long
run is clearly associated with a lower level of per capita income than
decreasing agricultural land area. For all tropical countries, the turning
point is a long run agricultural change index of just under 1.2. For lower
income countries the turning point is 1.3. Although continued agricultural land
13 Although only the preferred models are indicated in Table I, the panel
analysis was performed comparing OLS against one-way and two-way random and
fixed effects models. Alternative versions of these models also employed
White’s robust correction of the covariance matrix to overcome unspecified
heteroskedasticity.However,
heteroskedasticity proved not to be a significant problem in both regressions.
In the regression for all tropical developing countries, the F-test for the
pooled model and Breusch-Pagan LM test were highly significant, suggesting
rejection of the OLS model due to the presence of individual effects. The
Hausman test was significant only at the 10% level, suggesting that random
effects specification is preferred to the fixed effects model. The one-way
model tended to outperform the two-way effects model. In the regression for
lower income countries, the F-test for the pooled model, the LM test and the Hausman
test were all highly significant, suggesting that the fixed effects model is
preferred. The two-way model tended to outperform the one-way effects model.

Table
II Panel analysis of per capita income and long run
agricultural expansion for tropical developing countries, 1961–94 expansion
beyond these points does lead to a slight increase in GDP per capita,
this impact is short-lived. For all tropical countries, per capita income
starts to fall once the land area index reaches 2.3; for lower income countries
this occurs sooner at an index of 1.9. Note as well that for lower income
countries, there is very little increase in GDP per capita associated
with expansion of land over the 1.3 to 1.9 range. To conclude, even though a
developing economy is endowed with abundant natural resources, the country may
not necessarily be exploiting this natural wealth efficiently and generating
productive investments. Or, as Wright (1990, p. 666) suggests: “there is no
iron law associating natural resource abundance with national industrial
strength.” It is clear that the open access conditions and ill-defined property
rights under which many resources, and especially land, are exploited in
developing economies is partly to blame. It is also the case that in many
countries natural resource assets, including land, are not being managed so as
to maximise rents and/or whatever rents are being generated in the economy are
not being re-invested productively elsewhere, especially in tradable
manufacturing and other dynamic sectors.

VI.
Final Remarks

Although
our understanding of the role of natural resources in economic development has

improved
markedly in recent decades, there is still much to learn. Nevertheless, as I
have

argued
in this paper, the view that environmental and natural resources should be
treated as Figure 5. Projected trends in agricultural land expansion per
capita income for tropical developing Countries important economic assets,
which can be called natural capital, is becoming more accepted.

Armed
with this concept, economists are now able to show the conditions under which
depletion of this natural capital stock may or may not lead to more sustainable
economic development. However, the services provided by natural capital are
unique and, in the case of the ecological and life-support functions of the
environment, are not well understood. Improving our knowledge in this area is a
critical task. It is also one in which economists must learn to work more
closely with scientists from other disciplines, particularly biologists,
ecologists and other natural scientists. Such inter-disciplinary efforts are
especially relevant for a host of complex environmental management problems
facing the world today, such as biodiversity loss, climate change, and the spread
of biological invasions and infectious diseases (Barbier et al. 1994). Better
understanding of these complex environmental problems and of the value of
ecological services may also help eventually to resolve the “weak” versus
“strong” sustainability debate in economics. As I have noted in this paper, the
heart of this debate concerns whether the environment has an “essential” role
in sustaining human welfare, and if so, whether special “compensation rules”
are necessary in order to ensure that future generations are not made worse off
by natural capital depletion today. These issues are unlikely to be resolved in
the near future, and I have not attempted to do so here. Nevertheless, it is
clear that the very minimum criterion for attaining sustainable economic
development is ensuring that an economy satisfies weak sustainability conditions.
That is, as long as the natural capital that is being depleted is replaced with
even more valuable physical and human capital, then the value of the
aggregate stock – comprising human, physical and the remaining natural
capital – should be increasing over time. This in turn requires that the
development path of an economy is governed by principles somewhat akin to
Hartwick’s rule (Hartwick 1977). First, environmental and natural resources
must be managed efficiently so that the welfare losses from environmental
damages are minimized and any resource rents earned after “internalising”
environmental externalities are maximised. Second, the rents arising from the
depletion of natural capital must be invested into other productive economic
assets.

The
conclusion that efficient environmental resource management is the minimum
condition necessary for sustainable economic development may surprise those who
believe that the causality might run in the other direction. Proponents of the
latter view argue that the environmental Kuznets curve literature provides
evidence that environmental problems are likely to lessen as economies grow and
develop. However, as I have sought to clarify in this paper, the EKC literature
does not support such a conclusion. Rather, many EKC studies suggest that
specific policies to protect the environment are necessary for curbing certain
forms of pollution and resource depletion, both currently and in the future.
How key environmental indicators change with rises in per capita income
is an important issue, but what is of more fundamental concern is how different
policies can affect this relationship. Specifically, we need to determine what environmental
policies are required to ensure that the needs of the present are met without
compromising the economic opportunities to meet the needs of the future. With
regard to these bigger policy issues, estimating EKC relationships for various
indicators of environmental degradation is instructive of likely trends under
current policies, but is perhaps less helpful in indicating what additional
policies and instruments should be implemented. Finally, this paper has also
considered a recent paradox concerning the role of natural resources in
economic development: if natural capital is important for sustainable
development, why is the economic performance of many resource-abundant
developing countries lagging behind that of comparatively resource-poor
economies? The answer to this paradox seems to be fairly straightforward.
Simply because a developing economy is endowed with abundant natural resources,
it does not necessarily follow that the country will exploit this natural
wealth efficiently and reinvest resource rents in other productive investments.
Ill-defined and lack of enforcement of property rights that create “open
access” conditions for exploiting land and other natural resources in
developing countries are part of the problem. In addition, rather than ensuring
that any resource rents earned are re-invested efficiently into other
productive assets, current policies in resource-abundant developing economies
appear to work against this outcome.

Corruption,
bureaucratic inefficiency and polices biased in favour of special interests that
gain from excessive resource extraction or conversion also exacerbate these
policy failures. The result is that land expansion and increased exploitation
of new resource “reserves” in many resource-dependent developing economies are
not fostering a “takeoff ” into sustainable development but rather a “boom and
bust” pattern of economic growth and development.

In
conclusion, the importance of natural resources to economic development is now
wellestablished. How a country manages its natural capital stock is critical
for achieving sustainable economic development. Moreover, misinterpretations of
the EKC literature aside, the causal relationship is clearly from improved
environmental management to enhanced economic development and welfare, and not
the other way around. On the other hand, poor policies and the inefficient mismanagement
of natural resources can also be detrimental to growth and development. Of
course, it will always be difficult to determine what exactly is lost when we
deplete natural resources and degrade the environment. But at the very least,
economic policies should be in place to ensure that welfare-damaging
environmental externalities are corrected, the rents generated from the
depletion of natural capital are maximised, and that these rents are reinvested
into dynamic and innovative sectors in the rest of the economy.

Barbier,
E.B. and Damania, R. 2002, ‘Lobbying, Trade and Resource Conversion’, Paper
Presented at the Workshop on ‘Trade, Renewable Resources and Biodiversity’,
University of Tilburg, The Netherlands, September 5–6, 2002.